Consider this financial statement of a company…
If I were a promoter of this company and asked you to invest your money in it – and you did not know me personally – would you invest?
Okay, to sweeten the deal, I lower my asking price by 10%, would you invest now?
I share with you my optimistic view on the company’s future, and how you are going to earn great returns in the future. But would you still budge?
“Okay, what are you going to do with my money?” you ask me.
I say, “I’ll use around 80% of the money you give me to retire a part of my loan.”
“80% just to retire loan!” you wonder. “How much total loan do you have?”
“Just Rs 1,200 crore.”
“Rs 1,200 crore! And how much more would you have after you repay the loan using money from me and other shareholders?”
“I would still owe my banks Rs 900 crore!”
“Oh! 80% of shareholders money to retire less than 30% of your loan! How do you plan to repay the rest?”
“I will consider other alternatives in the future?”
“This sounds risky!”
“Yeah, but look at our awesome future!”
“Okay, but at Rs 900 crore of future debt, and assuming a 10% interest rate, you would still have to pay Rs 90 crore interest every year. Your current annual revenue is just Rs 100 crore and you are deep into losses!”
“Yeah, but the future is bright!”
“The future is always bright, but how do I price that future into your asking price?”
“But I’m asking for just Rs 200 per share!”
“But that values your company at Rs 1,600 crore given your shares outstanding of 8 crore?”
“True, but Rs 1,600 crore is not much given the bright future!”
“Maybe! But if I were to value you at even 25x P/E, which I will pay for a well-run business with a reasonably good history, it would mean that you must show me Rs 64 crore in net profit right away, i.e., Rs 1,600 crore divided by 25x P/E.”
“That profit would come soon. You see, out future is bright!”
“But how soon? Even if you earn, say, a 15% net profit margin, which is also a reasonably good assumption, it means you must earn revenue of Rs 420 crore to justify the current stock price!”
“Yeah, but we will earn Rs 400 crore in revenue very soon.”
“Really? That’s around 4x your current revenue!”
“Right! But didn’t I tell you that our future is bright?”
“Yeah, you’ve said it often! Is there anything more I should know about your business?”
“Yeah, the future is bright…and you can read it all in our 417-page offer document.”
Nishanth Muralidhar says
And since this is such an awesome deal , only for you , I will slash the asking price and extend the timeline in which you can invest your funds with me…but hurry .Offer closes soon!!!
Aditya Bhargava says
Nice article Vishal i was going through some facts the market cap of 1600 crores divided by current p/e leads you with 64 crore net profit.I tried with Asiant Paints, Atul Auto,Force Motors and Ashiana Housing but there net profit is no where close if i use your calculation. Can you please put some light on it.
Atul Auto Market Cap 1312 crore PE 32.49 Net Profit should be 1312/32.49 and is 40 crore
Same is the case with others
Make sure you see the TTM (Trailing twelve months net profit) and not last years net profit as PE is also TTM
Also be aware of standalone and consolidated numbers can be different so if your using standalone PE check standalone profit and not consolidated
And that is why i love reading your articles… Because that makes my future bright!
Striking. Piercing. Brilliant. Thanks!
Reni George says
The future is always bright,if you do not make profits,be sure you will get a ride…..we have many rides…
I love the way you have managed to explain it so succinctly and in a manner in which even my dog would understand.
Anand Gurumoorthy says
Your post was so succinct and well-written that I didn’t even want to peruse the 400+ page document. You are good at sarcasm. Should try more articles along that vein.
Awesome!! How I wish i had started reading your blog before the reliance power IPO …… and whatever followed!
Its the same case with the new IPO in Market… Adlabs Imagica…
ram chaturvedi says
you should write more articles in this fashion 🙂
while i realise that you admire munger/buffet, most of those lessons are advanced lessons , so to speak.
these are the kind of articles needed to open up the eyes of retail investors – great job!
They are right, promoters future is bright!
Thank you for the article
Pushkaraj Sherkar says
I though there was a requirement by SEBI that the listing company should be in profits for atleast 3 years before the listing date or something similar along that lines.
Akash Jhaveri says
Right on the money! Excellent write up.